The Schaller Law Firm is an aggressive litigation-minded firm that prides itself on aggressively defending mortgagees to protect their mortgage investments from lien stripping attacks in bankruptcy cases. The Schaller Law Firm aggressively defends mortgagees to ensure mortgagees have the best opportunity to save their mortgage investments and collect future mortgage payments on performing loans and collect future foreclosure-sale proceeds on non-performing loans.

Sunday, February 7, 2010

I was shocked at what I observed on January 29, 2010 in the US Bankruptcy Court for the Northern District of Illinois (Joliet, IL, Judge Barbosa presiding on behalf of Judge Black). I witnessed a debtor stripping and avoiding a junior mortgage lien under the following circumstances:

1. the junior lien holder failed to appear;
2. the junior lien holder failed to oppose the motion to strip and avoid the lien on procedural grounds that such a result can only be achieved via an adversary proceeding;
3. the junior lien holder effectively waived its right to an adversary proceeding;
4. the junor lien holder failed to contest the debtor's assertion that the junior mortgage was wholly unsecured and offered no evidence whatsoever as to the value of property;
5. the junor lien holder failed to offer any evidence as to the true fair market value of the property by admitting into evidence its own appraisal;
6. the junior lien holder allowed the debtor to establish the fair market value of the property by merely asserting the debtor's self-serving "belief" as to the value.

Debtor offered no appraisal. Debtor offered no broker's opinion. Debtor merely asserted what it believed was the true value. Debtor's counsel utilized debtor's assertion on Schedule A of the bankruptcy schedules to establish the fair market value of the property.

As a result, the bankruptcy court granted the motion to strip and avoid the lien. The junior mortgagee lost without a fight in a case I believe could have been won.

It's time for junior mortgagees to fight the ever-increasing lien stripping attacks. Lien stripping attacks are going to accelerate. It's time for the junior lien holders to start defending themselves aggressively.

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Sunday, January 24, 2010

Junior mortgagees can defeat lien stripping adversaries by attacking the underlying Chapter 13 case. A lien stripping complaint would be dismissed as moot if the underlying Chapter 13 case is dismissed for reasons unrelated to the adversary.
One attack on the underlying Chapter 13 case is a motion to dismiss for ineligibility. Such a motion would be appropriate where the to-be-stripped wholly unsecured junior mortgage debt is reclassified into unsecured debt --- which in turn results in the debtor’s total unsecured debt load exceeding the Section 109(e) unsecured debt limit.

This scenario existed in In re Russell & Joy Smith, 20 CBN 246 (Bankr. C.D.CA 2009). There, the court dismissed the debtors’ Chapter 13 case because debtors exceeded the unsecured debt limit after adding the junior mortgage lien balance to the other unsecured debt balance.
The Smith case presented the court with the issue of how secured residential mortgage debt should be treated in determining whether debtors qualify for Chapter 13 relief. The court found that wholly unsecured junior mortgages are counted as unsecured debt and partially secured senior mortgages are counted as secured debt for Section 109(e) purposes. The court based its determination on eligibility on the amount of debt and property values listed in debtors’ schedules --- because there were no allegations that the debtors acted in bad faith.
Debtors had wholly unsecured junior mortgages that, if treated as unsecured debt, would make them ineligible for Chapter 13 relief. The debtors argued that the junior mortgages were unliquidated because it was not yet known whether the debt would be determined to be secured. The court disagreed, ruling that the debts were liquidated because the court could determine whether they were secured at a simple hearing. In support, the Smith court cited Scovis v. Henrichsen (In re Scovis), 249 F.3d 975 (9th Cir. 2001), established how to treat wholly unsecured junior mortgages. In Scovis, the 9th Circuit held that completely undersecured liens must be counted as unsecured debt for purposes of Section 109(e).
The Smith court, however, found that the Scovis case did not apply to partially secured senior mortgages because Section 1322(b)(2) prohibits the modification of these mortgages. Thus, while the bankruptcy court may still value a debtor’s principal residence, the Code does not allow the court to modify an undersecured lien secured by debtors’ residence.
In sum, the court found that debt secured by a wholly unsecured junior trust deed must be counted as unsecured debt for Section 109(e) eligibility purposes where a debtor’s schedules show the senior deeds of trust exceed said debtor’s home value. However, trust deed debt will be counted as secured debt for Section 109(e) purposes where a trust deed is partially secured on a debtor’s primary residence.

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Saturday, January 23, 2010

A Pennsylvania bankruptcy court held that it did not have the discretion to ignore a debtor’s valid lien stripping action by exercising the court’s general equitable powers. In Korbe v. Department of Housing and Urban Development (In re Korbe), 18 CBN 741 (Bankr. W.D.Pa 2008), HUD held a third mortgage on debtor's homestead. Given that there was no equity in the debtor's residence above the first mortgage, the debtor sought an order stripping off HUD's lien.

The court said that there was no unique facts that would allow HUD to prevent the loss of its junior lien. The fact that the lien was secured by debtor's home did not change the outcome according to the court because Section 1322(b)(2)'s anti-modification provision does not apply to wholly unsecured junior mortgages.

HUD argued that the court had discretion to exercise its equitable powers as to the avoidance of HUD's lien, but the court disagreed. The court found that nothing in Section 506 of the Bankruptcy Code authorized the court to ignore a debtor’s valid lien stripping action in the name of equity. Indeed, equity follows the law and the United States Supreme court has declared that the bankruptcy courts’ equitable powers are to be exercised within the confines of the Bankruptcy Code.

While the facts of this case harmed the junior mortgagee's attempt to defend against the lien strip action, the court's holding may be helpful in future cases when the facts are reversed. This case revolved around a wholly unsecured junior mortgage. But, what if the facts showed that the mortgage was partially or negligibly secured --- say by a $1,000 or so.

First, a partially secured junior mortgagee would cerainly argue that the Supreme Court's decision in Nobelman controlled and prohibited the lien strip-down of any undersecured mortgages --- no matter how much of the lien was secured. Second, the Korbe case could also be cited in opposition to a debtor's argument that the court could utilize its equitable powers to strip a "barely" or "negligibly" secured junior mortgage. The argument would be that courts are not permitted to utilize their discretion and equitable powers to strip a negligibly secured junior mortgage --- since "equity follows the law" no matter the result.
Warmest Regards,

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Junior mortgagees can contest any lien stripping order that was entered with inadequate notice. Mortgagees should argue that proper notice required adherence to the manner of notice that fully complies with the Bankruptcy Rules--- including notice being mailed to the junior mortgagee and directed to an officer or agent, plus notice being sent via certified mail.

A lien stripping confirmation order was challenged because of inadequate notice in In re Stassi, 20 CBN 236 (Bankr. C.D.IL 2009). There, the court granted the junior mortgagee's motion for relief from the confirmation order that contained language stripping the junior mortgagee's lien. The court held that debtors who propose a strip off of wholly unsecured liens as part of a Chapter 13 confirmation process are responsible for ensuring that the creditor whose lien is to be stripped receives notice of the plan provisions, related motions, and the dates set for objections and hearings in a manner which fully complies with the Bankruptcy Rules.

In Stassi, the Chapter 13 debtors said their home was worth $270,000 and subject to two mortgages both held by United Community Bank. The debtors said they owed UCB $341,721 on the two mortgages, with the junior mortgage being wholly unsecured. The debtors’ plan proposed to void the junior lien and treat that claim as unsecured. The debtors’ plan was confirmed without objection.

More than two months after the plan was confirmed, the junior mortgagee asked for relief on the basis that it did not receive notice of the filing of the case or of the debtors’ proposed plan. The mortgagee said it learned of the bankruptcy filing only after the debtors defaulted on the payment of the second mortgage.

The junior mortgagee said the debtors informed it of the bankruptcy in response to the lender’s inquiry about the missing payment. The junior mortgagee’s request for relief was filed less than one week after learning of the bankruptcy filing. The lender asserted its belief that the debtor’s home was worth $380,000 and that both of its mortgages were fully secured.

The court said its practice is to allow debtors to strip off wholly unsecured mortgages through plan confirmation provided that service of the plan is made in the same manner as service of an adversary complaint.

The docket in this case indicated that service of the debtors’ plan was made on the junior mortgagee by regular mail at a bank branch located in Chatham, IL. The service was made by the clerk of court through the Bankruptcy Noticing Center. The mailing to the junior mortgagee was not directed to any officer or agent and was not made by certified mail. Although the debtors objected to granting the relief requested by the junior mortgagee, they provided no evidence that the mortgagee was served in accordance with the Rules, the court said.

The court granted the junior mortgage’s request for relief and declared that “Where notice to the creditor is inadequate, secured property will still vest in the debtor upon confirmation as provided by Section 1327(b), but will remain subject to the unavoided lien rather than vesting “free and clear” as permitted by Section 1327(c).”

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Mortgagees should argue that a wholly unsecured mortgage cannot be avoided by a bankruptcy court after a state court judge enters a default judgment in favor of the junior mortgagee in a state court foreclosure action. Mortgagee should assert that a bankruptcy court’s order to strip would be a violation of the Rooker-Feldman doctrine and would be outside of the court’s subject matter jurisdiction.

A court addressed a similar issue in Calabria v. CIT Consumer Group (In re Calabria), 20 CBN 212 (Bankr. W.D.Pa 2009). There, the court dismissed the debtors' complaint to strip-off a mortgage because it found that the court lacked subject matter jurisdiction to do so. The court found that the Rooker-Feldman doctrine precluded the bankruptcy court from considering whether a mortgage on the debtors’ home was invalid after a state court judgment of foreclosure had been granted on the mortgage.

The facts of the case showed that debtors executed two notes and mortgages on their principal home. The junior mortgage was assigned to a third party, which filed a foreclosure action against debtors after the debtors defaulted on the second loan. The junior mortgagee obtained a default judgment against debtors in the mortgage foreclosure case.

Shortly thereafter, debtors filed for Chapter 13 bankruptcy relief. Debtors petitioned the court to avoid the mortgagee’s junior lien because the recorded mortgage referenced the wrong address or contained no legal description. Debtors argued that state law required that a valid mortgage describe the property sufficiently to enable it to be located and identified. If the mortgage was invalid, there could be no foreclosure.

Nevertheless, the bankruptcy court rejected debtors’ argument stating that any ruling that the mortgage instrument was defective would be tantamount to the bankruptcy court concluding that the state court foreclosure judgment was “erroneously entered.” After al, the debtors’ complaint expressly requested that the bankruptcy court strike the junior mortgagee’s secured claim and issue an order to the state court requesting that the state court strike the judgment in mortgage foreclosure.

The bankruptcy court found that if it were to grant the requested relief, then it clearly would have the effect of negating the state court judgment. Under those circumstances, the bankruptcy court concluded that the affirmative claim asserted in debtors’ complaint was “inextricably intertwined” with the state court judgment rendered against debtors. So, the bankruptcy court found that debtors were requesting that the bankruptcy court do precisely what Rooker-Feldman prohibited: to undo the effect of the state court judgment. The bankruptcy court refused to do so and dismissed the case.

So, the Calabria opinion could be cited for the proposition that bankruptcy court’s cannot strip wholly unsecured junior mortgages if a state foreclosure court has already issued an order finding the junior mortgage lien as a valid, enforceable lien.

But, a clever debtor could attempt to distinguish Calabria on a factual basis, arguing that Calabria addressed the validity of the lien and not the value of the lien property. In a typical lien strip case, the validity of the second mortgage lien is not in question. The real question is the value of the lien property and whether the lien is wholly unsecured. So, a debtor could argue that the Rooker-Feldman doctrine in Calabria only emasculated the bankruptcy court’s power to address the validity of the lien, but did not affect the bankruptcy court’s power to value the lien property pursuant to Section 506(a).

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Friday, January 22, 2010

In re Nobleman v. American Savings Bank, 508 U.S. 324 (1993). Debtor’s attempted to strip-down an undersecured mortgage lien via the plan confirmation process. In their Chapter 13 debt repayment plan, debtor relied on §506(a)---which provides, inter alia, that an allowed claim secured by a lien on the debtor’s property “is a secured claim to the extent of the value of the property” and “is an unsecured claim” to the extent it exceeds that value--- to propose that the mortgage on their principal residence be reduced from approximately $70,000 to the residence’s $23,500 current fair market value.

The junior mortgage lender objected to the plan, arguing that the proposed bifurcation of the lender’s claim into a secured claim of $23,500 and an effectively worthless unsecured claim modified creditor’s rights as a homestead mortgage in violation of the anti-modification provisions of §1322(b)(2).

Section 1322(b)(2) allows a plan to “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence…”

The Supreme Court held that §1322(b)(2) prohibits a Chapter 13 debtor from relying on §506(a) to reduce an undersecured homestead mortgage to the fair market value of the mortgaged residence. Although debtor was correct in looking to §506(a) for a judicial valuation of their residence to determine the status of the lender’s secured claim, that valuation does not necessarily limit the lender’s rights as a claim holder, which are the focus of the anti-modification provisions of §1322(b)(2).

In the absence of a controlling Bankruptcy Code definition, it must be presumed that Congress left the determination of property “rights” in bankruptcy estate assets to state law. The court noted that the junior mortgagee’s “rights,” therefore, were reflected in the relevant mortgage instruments, which are enforceable under state law. Those rights included, among others, the right to repayment of the principal in monthly installments over a fixed term at specified interest rates, which were protected from modification by §1322(b)(2).

That section’s “other than” exception could not be read to protect only that subset of allowed “secured claims,” determined by application of §506(a), that are secured by a lien on the debtor’s home. Rather, the court found that the more reasonable interpretation was to read “a claim secured only by a homestead lien” as referring to the lienholder’s entire claim, including both its secured and unsecured components, since it would be impossible to reduce the junior mortgagee’s outstanding mortgage principal to $23,500 without modifying the mortgagee’s contractual rights as to interest rates, monthly payment amounts, or repayment terms.

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In re Hedenstrom, 08-27585 (Bankr. N.D.IL 2009)(J. Barbosa). The debtor sought to strip an allegedly wholly unsecured junior mortgage. Specifically, debtor alleged that the fair market value of the debtor’s homestead was $200,000 with a senior mortgage in the amount of $208,469. However, the senior lender filed a proof of claim in the amount of only $202,806. Therefore, the senior lender’s equity cushion was only $2,806. The junior lender filed a proof of claim in the amount of $51,578.

The junior lender failed to challenge the lien stripping on factual grounds. The lender failed to obtain an appraiser that showed the true fair market value of the property to be a mere $3,000 more than the debtor’s appraisal. Had the junior lender done so, the lender would have saved the entire $51,578 lien because its claim would have not been wholly unsecured.

The junior lender also failed to challenge the lien stripping on legal grounds. The lender could have argued that debtor failed to honor the Bankruptcy Code and Bankruptcy Rules by attempting to strip the lien via a motion instead of via an adversary proceeding.

Instead, the junior lender decided to challenge the lien stripping by denying that a wholly unsecured lien can be stripped-off no matter what, citing the Supreme Court’s decision in Nobelman v. American Savings Bank, 508 U.S. 324 (1993). However, Judge Barbosa rejected creditor’s legal challenge after addressing the interplay of §506(a) and the anti-modification provision of §1322(b)(2). Then the court found that the junior mortgage lien was wholly unsecured. The court granted debtor’s motion to avoid the junior mortgage lender’s lien.

Lesson to learn: a more aggressive defense could have won on valuation grounds or procedural grounds and saved the lender more than $50,000!

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In re Forrest, 410 B.R. 816 (Bankr. N.D.IL 2009)(J. Schmetterer). In Forrest, the court reviewed a debtor’s attempt to strip-off and avoid a lien on a junior mortgage by inserting lien stripping language in the chapter 13 plan with the hope that the court would confirm the plan containing said language. The creditor objected asserting that a wholly unsecured second mortgage cannot be avoided via the plan confirmation process. Instead, the creditor asserted that lien stripping and avoiding can only be accomplished via an adversary proceeding.
The Forrest court presented the issue before it as whether a debtor may strip off a junior mortgage that is allegedly wholly unsecured through a chapter 13 plan, rather than through an adversary proceeding. Ultimately, the court held that the debtor may NOT strip off the junior mortgage through the chapter 13 plan because the Bankruptcy Code, Bankruptcy Rules, and the US Constitution require debtor to file an adversary proceeding to do so.

The court noted that chapter 13 plans normally provide extensive financial details. However, the court also noted that it is not common that plans include provisions in the nature of declaratory judgments that purport to adjudicate legal issues between parties if the plan is confirmed.

The Forrest court noted that the Seventh Circuit Court of Appeals rejected such an effort by a student loan debtor attempting to discharge student loan debt by a similar tactic in In re Hanson, 397 F.3d 482, 284 (7th Cir. 2005). The Seventh Circuit believed that the tactic of utilizing the plan to obtain a “declaratory judgment” was employed by debtor’s in the hope that an unsuspecting bankruptcy court would confirm the plan and thus bind the lender who failed to recognize the ploy in time to object to confirmation.

The Forrest court also believed that the Bankruptcy Code and Bankruptcy Rules require an adversary proceeding to strip off and avoid a lien. The court noted that Rule 7001 required an adversary proceeding to determine validity, priority, or extent of lien or other interest in property. The court believed the stripping and voiding of a wholly unsecured lien has the same result as declaring the lien void in an adversary proceeding--- namely, the entire claim is treated as an unsecured claim.

The court objected to debtor’s attempt to flaunt both substantive and procedural provision of the Bankruptcy Code and Rules through a meaningless incantation inserted into the proposed plan. In particular, the court focused on the heightened notice provisions set forth in the Code and Rules.

The court believed debtor’s failure to comply with the heightened notice provisions violated the US Constitution by depriving the junior mortgagee of life, liberty, or property, without due process of law. Therefore, the court held that where the Bankruptcy Code and Bankruptcy Rules require the debtor to prosecute an adversary proceeding, the debtor cannot instead include a provision in the Chapter 13 plan and expect it to bind the junior mortgagee.

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First Mariner Bank v. Johnson, 411 B.R. 221 (USDC D. Md. 2009). In First Mariner Bank, the court reviewed the interaction between two provisions of the Bankruptcy Code, 11 U.S.C. §506(a) and 11 U.S.C. §1322(b)(2). The issue before the court was whether the anti-modification provisions of §1322(b)(2) prohibited debtors from stripping-off and voiding a lien on debtors’ residential property if there was insufficient equity in the residence to cover any portion of that lien. The court held that debtors may strip-off and void wholly unsecured liens on residential property.

The First Mariner Bank court believed that the Bankruptcy Code’s anti-modification provision was inapplicable to wholly unsecured liens, which were not “secured claims” within the meaning of the code. Whether a lienholder has a “secured claim” depends on whether its interest in the collateral has economic value. Moreover, the court noted that such liens were usually second mortgages and thus permitting them to be stripped-off would not create an “absurd result.” The court further noted that second mortgages are rarely used to purchase homes and so finding wholly unsecured second mortgages NOT subject to anti-modification clause of §1322(b)(2) would have, at best, a minimal impact on discouraging home building and buying.

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In re Chaudhry, 411 B.R. 282 (Bankr. E.D.Va 2009). In Chaudhry, the court distinguished between the effects of a case dismissal and the effects of a case being fully administered. The court noted that actions taken in a dismissed case may be undone, whereas actions taken in a fully administered case remain as ordered by the court. In particular, the Chaudhry court noted that liens avoided under §506(d) are reinstated if the case is later dismissed, whereas liens avoided in a fully administered case remain avoided at the conclusion of the case.

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